April 8 (SeeNews) - Fitch Ratings said it has affirmed North Macedonia's long-term foreign-currency issuer default rating (IDR) at BB+, with a stable outlook.
North Macedonia's 'BB+' rating is sustained by stable macroeconomic policies and EU accession efforts, although challenges persist with public debt exposure to exchange rate risk, euroisation in banking, high unemployment, and weak productivity due to informal economy dynamics and skills mismatches, the global ratings agency said in a statement on Friday.
The ratings agency also said in the statement:
"Fitch Ratings - London - 05 Apr 2024: Fitch Ratings has affirmed North Macedonia's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'BB+' with a Stable Outlook.
A full list of rating actions is at the end of this rating action commentary.
KEY RATING DRIVERS
Rating Fundamentals: North Macedonia's 'BB+' rating is supported by a record of credible and consistent macroeconomic policies that underpin the longstanding exchange rate peg to the euro, more favourable governance indicators than peer medians, and an EU accession process that acts as a reform anchor over the medium term. Set against these factors are the greater exposure of public debt to exchange rate risk, banking sector euroisation, and still-high structural unemployment, partly reflecting a large informal economy and skills mismatches, together with weak productivity growth.
Investment, Consumption to Drive Growth: Fitch expects growth to strengthen in 2024 to 2.9% from a provisional 1% in 2023. Private consumption should remain the main contributor to growth owing to an improvement in real wages. Work on the 8/10d highway project will drive investment spending, and continued net FDI inflows will lift export capacity. We forecast growth to pick up further in 2025 to 3.6% as the prospects for key trading partners improves, although a failure of this to occur is the main near-term downside risk. Financing flows from the EU's new Western Balkans growth plan (potentially worth 6% of GDP by end-2027) are an upside.
2023 Growth Uncertainty: Preliminary Q4 data put growth in 2023 at less than half of central bank, Ministry of Finance and IMF expectations and below Fitch's projection of 2.4% from its October review. The impact of weakness in key trading partners, a slower than expected start to the 8/10d project and poor agricultural performance pointed to some loss of momentum in 4Q23. However, it appears that inventories, which are not disaggregated in the data, had the major impact. Other official data point to a stronger picture in real terms, and the GDP deflator was surprisingly low.
Fitch has used the official projections while noting the potential upside in subsequent planned revisions to both real and nominal outturns for 2023.
Budget Deficit to Narrow: Fitch expects a narrowing of the general government deficit to 3.8% in 2024 from 4.9% in 2023, owing to budgeted spending adjustments, recent revenue-raising measures and a pickup in economic activity. Energy measures (estimated to save 0.5% of GDP) and adjustments to agricultural subsidies will be backed up by full-year revenues from the removal of tax exemptions and VAT hikes introduced in September 2023.
Stronger growth and a further reduction of energy subsidies will narrow the deficit to a forecast 3.4% in 2025. The 2023 deficit was smaller than the official target in nominal terms, but preliminary GDP data put it above the target of 4.6%. The 8/10d project (expected to cost around 2% of GDP per year over the five years of construction) is the main fiscal risk due to potential cost overruns and the lack of a final costing estimate for the project.
Rise in Debt Partly Pre-financing: General government debt is forecast to jump in 2024 to 55.2% from 53.1% in 2023 (BB median 53.1%), owing to the pre-financing of a January 2025 Eurobond maturity, before falling to 54.3% at end-2025. Government guarantees were 8.4% of GDP at end-2023. Government debt is significantly exposed to FX risk, as at end-2023 only 29% was local-currency-denominated and a further 66% of government debt was euro-denominated. However, these risks are mitigated by the credible exchange-rate peg. The government raised a record amount from the domestic market in 2023 and there is a solid pipeline of IFI financing.
FDI to Cover Current Account Deficit: Fitch expects the current account to return to a deficit in 2024 of 2.8% of GDP, after a fall in imports (due to lower energy imports and the drawdown of imported inventories built in 2022) caused a rare surplus of 0.7% of GDP in 2023. The deficit this year will be driven by imports of goods and services associated with the 8/10d project. Stronger growth in key trading partners is expected to narrow the deficit to 2.2% in 2025.
Net FDI inflows of 3.5-4% of GDP will support further reserve accumulation, with current external payments coverage projected to remain around 4.3 months in 2024 and 2025 (expected BB median 4.4 months), and underpin the exchange rate peg. Comfort with the reserve position means the authorities no longer want to draw funds under the Precautionary and Liquidity Line with the IMF (expiring November 2024).
Impending Elections: Opinion polls point to a change in government at legislative elections in May. VMRO, the largest opposition party, leads the way in opinion polls, but without sufficient support for an overall majority. A coalition with one of the ethnic Albanian parties appears likely. Political parties have yet to announce their electoral platforms, but there are no indications of significant differences on economic policy.
VMRO has expressed some reservations over the wording of the constitutional amendment necessary as part of North Macedonia's EU accession process, but both ethnic Albanian groupings are strongly committed to EU accession and a delay appears more likely than a derailment of the process.
Inflation Normalising: Inflation dropped to 3% in February, from a peak of 19.8% in October 2022, reflecting base effects, tighter monetary policy and more recently a temporary freeze on some prices that has now lapsed (and will feed into the numbers in March). Core inflation has also fallen and inflation expectations eased.
Rapid growth in wages, up 16.5% in January, is a upside risk to inflation, particularly in the event of post-election public-sector wage adjustments, but profit margins have been built in recent years, providing a buffer. Fitch forecasts inflation to average 3.7% in 2024 and 2.8% in 2025 (from 9.4% in 2023). Fitch expects an ECB rate cut (forecast by Fitch in June) to start the easing cycle in North Macedonia.
Sound Banks: The banking sector continues to perform well. Sectoral profits jumped by 48% in 2023 due to higher net interest income and improved operational efficiency. Return on assets was 2% last year and return on equity 16.1%. Capital adequacy was at a 17-year high of 18.1%, non-performing loans finished the year at a long-term low of 2.8% (with coverage 150%), liquidity is high (with a liquidity coverage ratio of 264%) and solvency above pre-pandemic levels.
Higher lending rates and macro-prudential measures slowed the growth in mortgage lending to just over 10% and eased the pace of house price growth to 7% yoy in 4Q23 from 20.5% a year earlier. Deposit denarisation rose by almost 2pp to 49.8% at end-2023, retracing most of the losses since the start of the war in Ukraine.
ESG - Governance: North Macedonia has an ESG Relevance Score (RS) of '5[+]' for both Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption. Theses scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model. North Macedonia has a medium WBGI ranking at 53 reflecting a recent record of peaceful political transitions, a moderate level of rights for participation in the political process, moderate institutional capacity, established rule of law and a moderate level of corruption.
RATING SENSITIVITIES
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
-Public Finances: Higher-than-forecast and rising general government debt/GDP over the medium term, for example, due to weaker growth prospects or looser fiscal policy.
- Structural: Adverse political developments that negatively affect governance standards, the economy and EU accession progress.
-External Finances: Pressure on foreign-currency reserves and/or the currency peg against the euro, caused by a deterioration in the external position.
Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade
- Structural/Macro: Improvement in medium-term growth prospects and/or governance standards, for example, due to progress towards EU accession and reduction in political and policy risk.
-Public Finances: A sharp and sustained decline in general government debt/GDP, reflecting implementation of fiscal reforms
SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)
Fitch's proprietary SRM assigns North Macedonia a score equivalent to a rating of 'BB' on the Long-Term Foreign-Currency (LT FC) IDR scale.
Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to SRM data and output, as follows:
- Macro: +1 notch, to reflect the deterioration in the SRM output driven by the pandemic shock and the high inflation stemming from the war in Ukraine. The deterioration of the GDP volatility variable and the jump in inflation reflects a very substantial and unprecedented exogenous shocks that have hit the vast majority of sovereigns, and Fitch currently believes that North Macedonia has the capacity to absorb them without lasting effects on its long-term macroeconomic stability.
Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
COUNTRY CEILING
The Country Ceiling for North Macedonia is 'BBB-', 1 notch above the LT FC IDR. This reflects moderate constraints and incentives, relative to the IDR, against capital or exchange controls being imposed that would prevent or significantly impede the private sector from converting local currency into foreign currency and transferring the proceeds to non-resident creditors to service debt payments.
Fitch's Country Ceiling Model produced a starting point uplift of 0 notches above the IDR. Fitch's rating committee applied a +1 notch qualitative adjustment to this, under the Long-Term Institutional Characteristics pillar reflecting the importance of FDI to North Macedonia's open economy and the EU accession process.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG CONSIDERATIONS
North Macedonia has an ESG Relevance Score of '5[+]' for Political Stability and Rights as World Bank Governance Indicators have the highest weight in Fitch's SRM and are therefore highly relevant to the rating and a key rating driver with a high weight. As North Macedonia has a percentile rank above 50 for the respective Governance Indicator, this has a positive impact on the credit profile.
North Macedonia has an ESG Relevance Score of '5[+]' for Rule of Law, Institutional & Regulatory Quality and Control of Corruption as World Bank Governance Indicators have the highest weight in Fitch's SRM and are therefore highly relevant to the rating and are a key rating driver with a high weight. As North Macedonia has a percentile rank above 50 for the respective Governance Indicators, this has a positive impact on the credit profile.
North Macedonia has an ESG Relevance Score of '4[+]'for Human Rights and Political Freedoms as the Voice and Accountability pillar of the World Bank Governance Indicators is relevant to the rating and a rating driver. As North Macedonia has a percentile rank above 50 for the respective Governance Indicator, this has a positive impact on the credit profile.
North Macedonia has an ESG Relevance Score of '4[+]' for Creditor Rights as willingness to service and repay debt is relevant to the rating and is a rating driver for North Macedonia, as for all sovereigns. As North Macedonia has track record of 20+ years without a restructuring of public debt and captured in our SRM variable, this has a positive impact on the credit profile.
The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit [...]."